Business, Bankruptcy, and Beliefs: the Financial Demise of NBA Stars

IZA DP No. 7238 Business, Bankruptcy, and Beliefs: The Financial Demise of NBA Stars Ruby Henry February 2013 DISCUSSION PAPER SERIES Forschungsinstitut zur Zukunft der Arbeit Institute for the Study of Labor Business, Bankruptcy, and Beliefs: The Financial Demise of NBA Stars Ruby Henry Rutgers University and IZA Discussion Paper No. 7238 February 2013 IZA P.O. Box 7240 53072 Bonn Germany Phone: +49-228-3894-0 Fax: +49-228-3894-180 E-mail: [email protected] Any opinions expressed here are those of the author(s) and not those of IZA. Research published in this series may include views on policy, but the institute itself takes no institutional policy positions. The IZA research network is committed to the IZA Guiding Principles of Research Integrity. The Institute for the Study of Labor (IZA) in Bonn is a local and virtual international research center and a place of communication between science, politics and business. IZA is an independent nonprofit organization supported by Deutsche Post Foundation. The center is associated with the University of Bonn and offers a stimulating research environment through its international network, workshops and conferences, data service, project support, research visits and doctoral program. IZA engages in (i) original and internationally competitive research in all fields of labor economics, (ii) development of policy concepts, and (iii) dissemination of research results and concepts to the interested public. IZA Discussion Papers often represent preliminary work and are circulated to encourage discussion. Citation of such a paper should account for its provisional character. A revised version may be available directly from the author. IZA Discussion Paper No. 7238 February 2013 ABSTRACT Business, Bankruptcy, and Beliefs: The Financial Demise of NBA Stars* The financial troubles of professional athletes are an ongoing topic of intrigue. In general, the zealousness brought to private equity schemes are a common factor in observed financial insolvency. Considering the behavioral attribute of self-confidence I propose a simple model which explains entrepreneurial activity and adverse financial outcomes. The model implies that investment effort increases with self-confidence, while promoting financial solvency. Constructing a unique database of NBA players affords a singular opportunity to measure confidence directly from behavior, avoiding bias from self-reported surveys. In addition, I observe for-profit business ventures and use this data to test the model’s implications for the outcomes of both entrepreneurial activity (investment effort) and bankruptcy. Without correcting for endogeneity it does appear that starting businesses causes bankruptcy. After using charitable foundations as an instrument, however, the data confirms the model’s prediction – that investment effort is associated with financial solvency. That said, I also find that the effect of confidence on bankruptcy to be non-monotonic. Having some confidence decreases the probability of bankruptcy, but high levels increase this probability. JEL Classification: D10, I20, J13 Keywords: self-confidence, bankruptcy, athletes, entrepreneurs influence, entrepreneurship Corresponding author: Ruby Henry Department of Economics Rutgers University 75 Hamilton Street New Brunswick, NJ USA E-mail: [email protected] * I thank Lawrence Jules, Greg Moore, Jennifer Hunt, Anne Piehl, John Landon-Lane, Roger Klein, Norman Swanson, Gilles Saint-Paul, Bernard Salanié, and seminar participants at IZA, Wesleyan and Rutgers. 1. Introduction The …nancial troubles of many professional athletes are well-documented. The exceed- ingly high incomes of these players make the phenomenon all the more interesting. For example, Vin Baker was the 8th pick in the 1993 National Basketball Association (NBA) draft and played for 13 years in the NBA which resulted in approximately $93 million dollars in earnings. His Connecticut home was foreclosed in 2008 for approximately $2 million dollars. Foreclosures are not the worst event, however. Consider Derrick Cole- man who was the 1st pick in the 1990 Draft and played for 15 years in the NBA. His estimated career earnings are $87 million. He …led for bankruptcy in 2010. A scienti…c examination of this phenomena was heretofore absent. I propose a simple model which explains adverse …nancial outcomes and test it on a unique hand-collected dataset of NBA athletes. Though the model is general to entrepreneurial activity, using this particular source of data allows me to observe personal characteristics as self- con…dence that would otherwise be unobserved or wrought with biases. Benabou and Tirole [2002] show that self-con…dence increases the motivation to undertake tasks and that too much con…dence can cause an individual to exert e¤ort when it is optimal to abstain. With this in mind, I model the individual’sprobability of successful ventures as a function of investing e¤ort and self-con…dence. The model implies that the probability of solvency is increasing in e¤ort. Furthermore it is increasing in self-con…dence up to a point and then decreasing for very high levels of con…dence. This is intuitive as a degree of self-con…dence is needed to undertake investment, however too much con…dence leads to nonoptimal behavior. To test these implications, I use data from on-the-job behavior of these athletes. To be sure, their general task is to score points, however there are several approaches to completing this task in the form of 3 basic types of shots each with a distinct di¢ culty level. I proxy self-con…dence with attempts at the most di¢ cult type of shot controlling for the actual observed ability to shoot these di¢ cult shots, among other factors. 2 Increasing this measure of self-con…dence by 1 standard deviation, increases the number of entrepreneurial pursuits by .10. This is non-negligible considering that the average number of these pursuits is .37. These for-pro…t entrepreneurial pursuits are the empiri- cal counterpart of e¤ort in the model. To estimate the e¤ect of e¤ort and self-con…dence on bankruptcy, I …rst address the endogeneity of e¤ort. Imagine that one is facing a fall in earnings or other type of …nancial distress. A plausible course of action is to start investing in private equity ventures to generate future income. In this way, investment e¤ort would be endogenous. To deal with this, I use charitable endeavors as an instrument for investment e¤ort. Without the endogeneity correction, investment is positve predictor of bankruptcy. Correcting for the upward bias, however, yields a negative e¤ect of investment on bankruptcy consistent with the model. 2. A Theory of Individual Solvency 1 2.1 Model Agents decide on a time allocation of (Leisure and Investment E¤ort). Their payo¤ is the sum of (1) present utility from leisure and (2) the utility of expected wealth. 2.1.1 Perceived Probability of Financial Solvency An individual’s perceived probability of solvency is i . It is a function of their self- con…dence, i [0; 1], which is known to them, and the e¤ort they choose to put into 2 e investment ei [0; 1]. 2 i = iei (1) 1 Solvency means …nancial soundness, well-being, competence. The opposite of bankruptcy or …nancial e distress. 3 The equation above re‡ects that the probability of successful entrepreneurship increases with the e¤ort made and with how able the agents view themselves to be. These two forces are complementary and strongly so. In this simpli…ed model, if no e¤ort is made, an individual will never believe they will succeed. Similarly if the individual has no self-con…dence, success is unfathomable. 2.1.2 Utility The present utility of an individual is: U(i); (2) where i is leisure time. Total time is normalized to 1, thus i = 1 ei. The cost of e¤ort, (e), is utility from leisure: (e) = U(1 e). I assume that the marginal cost of e¤ort is positive, 0(e) = U 0(1 e) > 0, and increasing, 00(e) = U 00(1 e) > 0. In addition to present utility, agents expect utility from wealth. If the individual remains solvent, they expect to keep wealth Wi. If the individual goes bankrupt they will lose their wealth. For simplicity, the weights on present utility and the future utility are equal. 4 2.2 Choosing E¤ort Level Agents maximize expected utility EVi = U(1 ei) + Wi (3) i subject to i = iei . e The F.O.C. is: U 0(1 ei) + iWi = 0 (4) 1 2 De…ning = [U 0] , the optimal e¤ort level is : e = 1 [iWi] (5) i 3. Implications for E¤ort and Perceived Success Proposition 1 @ei (i) = 0 [xWi] xWi > 0 @ The individual’sinvestment e¤ort is increasing in con…dence. This is the complemen- tarity between the factors from the individual’sperception of the success probability. 2 The assumption 00(e) > 0 implies U 00( ) < 0, which ensures a maximum. > 0; 0 < 0: 5 Proposition 2 (i) The perceived probability of a successful venture: i = ei. @i @ei (ii) @ = @ + ei > 0 e When con…dence increases, the perceived probability of success increases. This arises through the direct e¤ect of on the perceived outcome probability and the indirect e¤ect of increasing e¤ort. 4. Testing the Model’sImplications Testing the implications above requires suitable measures of e and . I build a data base with 7 years of NBA draft data (1990-1996) including various personal and professional characteristics of the players. The data are a result of searches of public sources including Wikipedia, nba.com, and basketball-reference.com. Because of the high-pro…le of the individuals, there is a wealth of information available. As mentioned above, NBA players are a group that lend themselves to this study. To understand the strengths and limitations, there are many myths about this group which are dispelled with basic tabulations.

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